Fed Rate Cut Spurs 4% Rally in Stocks

123jump.com Staff
16 Dec, 2008
New York City

The Fed cut rates to the lowest level possible and raised prospect of lower prices and providing more liquidity by printing money. The Fed lowered the key lending rate from 1% to a range between zero and 0.25%. Financials and insurance companies rallied as stock indexes jumped more than 3%.

[R]3:25PM New York – U.S. stocks surge after the Fed lowered rate to near zero and reaffirmed its promise of providing more liquidity to stabilize financial markets.[/R]

U.S. Federal Reserve lowered key lending rate to the lowest level possible and repeated the prospect of price declines and deflation. The Fed earlier assertions for a similar rate cuts in 2003 and 2004 have proven to be wrong.

The Federal Open Market Committee unanimously voted to lower the target rate to a range between zero and 0.25% from 1%. Most economists were looking for a rate of 0.5% and not a target range.

The Fed has exhausted its ability of setting rate and with the near zero rates the Fed is looking to provide liquidity in the old fashioned way, by printing money. Since the collapse of Lehman Brothers the Fed balance sheet has ballooned from $1 trillion to $2.2 trillion and is likely to enlarge in the next months. The current Fed balance sheet expansion does not include $700 billion in TARP under U.S. Treasury.

The Fed prefers to use the phrase “quantitative easing” which is nothing but euphemism for providing liquidity by printing money. The Fed is raising the prospect of deflation as raised by former Chairman Greenspan in 2003 and 2004 as an excuse to lower rates which led to a massive reckless lending in the housing sector.

Though inflation forces have subsided considerably after the recent collapse in the energy and commodities prices, outside the energy and metals, prices still remain high and are on the rise but at a slower pace.

Consumer prices in 2008 are still higher than they were in 2005 and 2006 for most consumer items.

The Fed statement noted, “The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level.

As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant.”

The Fed is sending a clear message that it will keep printing till the economy starts reflating, but it is not clear what abilities and tools the Fed have to contain inflation when it surges at a later date.

The imprudent low interest rates by Greenspan brought us the housing market bubble, and what will bring the Bernanke “quantitative easing” to us in the years to come?

The central bank in Japan carried a similar experiment for nearly a decade with little success. The Bank of Japan provided liquidity to banks and kept rates to at zero between 2001 and 2006 in the hopes that banks will increase lending.

However, the most banks used the funds to increase reserve and invest overseas and failed to increase lending. Japan stock market indexes even today are trading at 80% below their peaks reached in the eighties.

However, U.S. stocks rallied after the rate cut and Fed stance was released. Banks surged and led the gainers in financial and broader market.

Dow Jones industrial Average gained 230.98 to 8,799 and the Nasdaq increased 49.92 to 1,558.26.

Bank of American ((BAC)) gained 46 cents to $14.57, Wells Fargo ((WFC)) increased $1.90 to $27.97 and Prudential Financial ((PRU)) jumped $3.45 to $28.10. Goldman Sachs increased $9.75 to $76.21. Citigroup rose 70 cents to $$8.10.

Google ((GOOG)) led the gainers in tech sector with a rise of $13.12 to $323.83.

Europe Markets Review

In London FTSE 100 Index closed higher 31.52 or 0.74% to 4,309.08, in Paris CAC 40 Index increased 66.00 or 2.07% to close at 3,251.66 and in Frankfurt DAX index higher 75.09 or 1.61% to close at 4,729.91. In Zurich trading SMI increased 40.60 or 0.73% to close at 5,567.14.

Asian Markets Review

The Nikkei 225 Index in Tokyo closed lower 96.64 or 1.12% to 8,568.02, Hang Seng index in Hong Kong increased 83.26 or 0.55% closed to 15,130.21 CSI 300 index in China higher 19.42 or 0.98% closed to 1,994.45. ASX 200 index in Australia decreased 35.20 or 0.98% to close 3,556.20. The KL Composite index in Malaysia higher 8.33 or 0.98% closed to 854.80.

The Kospi Index in South Korea increased 3.37 or 0.29% to close at 1,161.56. SET index in Thailand closed higher 8.25 or 1.89% to 445.31 and JSE Index in Indonesia decreased 16.44 or 1.21% to 1,342.84. The Sensex index in India increased 144.59 or 1.47% closed to 9,976.98.